What are RBS shares worth?

A bit premature, since I haven't seen the prospectus for the rights issue yet, but I thought I'd have a deep think about what RBS shares are really worth, and whether it's smart to continue holding. My gut says "hold at all costs", but am I just avoiding crystallising a big loss?

Net tangible assets
At the interims assets were £67bn, of which £5.8bn were minority interests, and £8.3bn were non-ordinary equity. £27bn were intangible assets. You could munge those in a variety of ways, but I reckon the ordinary shareholders have about £20.5bn of tangible assets.

At the moment there are 16bn shares, so 128p per share.

Post rights issue there will be about £35bn of ordinary shareholder equity, but 38bn shares. So about 92p per ordinary share.

Of course there are worries over further writedowns which might eat into these assets. On the other hand, this gives no value to RBS's brands: RBS, Natwest, Churchill, Direct Line, Citizens, Charter One, ABN Amro, Ulster Bank, Coutts, etc..

Earnings
This is the key question. Can RBS sustain anything like their previous levels of earnings? Obviously their funding costs will rise, but can they just pass this on to their customers? Securitisation and some other revenue sources will probably be blocked indefinitely. They still have the expertise to compete effectively, and many banks will be in the same boat, so surely they can earn an adequate return on their other business lines.

I'll have a stab at £5bn post-tax, as a hypothetical figure. That's 13.1p per share after dilution. At a P/E of 10 that would mean 131p fair value. But: is a P/E ratio of 10 reasonable? An ultra-safe (extremely well-capitalised) bank earning a RoE of 14% should trade on a premium due to its growth prospects. On the other hand, RBS is likely to have a curtailed appetite for growth for some time to come, so such a good RoE is largely wasted.

Shareholder return
Of course shareholder return is the only realistic way to value a company, but it's also the hardest. I think we can expect:

• Non-core disposals, such as insurance, etc.. helping to pay back preference shares ASAP. Let's assume a £5bn boost to capital attributable to ordinary shareholders, and the end of the 12% payout on the preference shares. But a hit to post-tax earnings of about £600m per year.
• Shrinkage of the balance sheet and risk-weighted assets in Global Banking and Markets. Perhaps a reduction in risk-weighted assets of £80bn over the medium-term, resulting in £8bn of surplus capital. A hit to post-tax earnings of £1.2bn.
• In the short-run, impairments running ahead of better margins, but longer term more attractive returns on residential mortgages.

That would suggest £8bn of excess capital to return to shareholders. Earnings around £5bn in the medium term. The potential for higher dividend payments in the absence of growth. So perhaps 21p per diluted share in capital return, combined with 131p per share value based on earnings. So around 150p as a reasonable value for the diluted shares.